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Unrest, and hope, for developing economies: Olive

The alarming social unrest in emerging economies worldwide has a common thread: a sharp slowdown in once-torrid economic growth. The disturbances so graphically depicted in the media often appear to be ethnic or religious clashes or uprisings against autocracy. Those elements are playing a role. But the real driver of discontent in emerging economies is the failed promise of ever-increasing middle-class prosperity.

Most of the estimated 800 daily riots and public demonstrations in China result from factory layoffs. Striking miners in South Africa and street protests against the rule of Russia’s Vladimir Putin had become commonplace even before the recent weeks of rioting in São Paulo and Rio, and the military ouster this week of Egyptian president Mohammed Morsi in a Cairo stricken by blackouts, food shortages and rampant unemployment.

The earlier popularity of such leaders is understandable. Beijing’s economic reforms of recent decades have lifted hundreds of millions of Chinese from deprivation. India’s economic miracle, modeled on China’s market liberalizations, created a middle class of about 400 million people — larger than the entire U.S. population. Turkish per capita income tripled after Erdogan first took office. Lula da Silva’s dramatic makeover of the Brazilian economy, underpinned by full-employment goals, propelled tens of millions of Brazilians into a new middle class.

An awestruck financial media in the West took the widespread economic dynamism in the developing world to be permanent — an overdue industrial revolution and triumph of free-market ideology. More’s the pity, so did shoppers on the high streets of Rio, Shanghai, Mumbai and Istanbul, now lined with Cartier, Hermès and Louis Vuitton boutiques.

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But the simultaneous boom in so many emerging economies was both unprecedented and unsustainable. “Normally, each emerging nation is at a different stage in its economic life,” Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, and author of Breakout Nations, wrote in the U.K. Financial Times this week. “Crisis gives birth to reform, which flowers into a boom, which matures into political complacency, which ages into a new crisis.”

Apart from so many emerging economies boasting a new affluence at the same time, the dreary truth is that a fairly traditional boom-bust cycle has been playing out — with a few twists marking the current low point:

Artificial stimulus. When North American shoppers began their spending strike at the onset of the Great Recession, an export-reliant China compensated by ramping up its already extravagant state spending on infrastructure building. Now China is suffering a credit crisis. With a debt-to-GDP ratio that has soared to a stratospheric 200 per cent-plus (Canada’s is about 33 per cent), Beijing is trying to curb the pell-mell lending by state banks that it until recently encouraged. And Brazilians complain that Brasilia shouldn’t have pumped so much cash into China-like infrastructure megaprojects at the expense of social-protection programs and education.

Over-reliance on China. By 2008, China’s economy had grown too large to sustain continued double-digit GDP growth, which has been decelerating in recent years. That has hurt the many developing world countries reliant on exports to China, particularly of natural resources. Canada’s own growth prospects have dimmed as hopes of using Chinese exports to reduce dependence on the U.S. market have decidedly cooled.

Over-reliance on resource exports. Critics of an emerging Canadian “petro-economy” need to check out Russia, a genuinely single-suited petro-economy that cannot build a decent car. The latest emerging markets boom, beginning in 2003, saw skyrocketing prices for the commodities that remain the backbone of most developing world economies. But come the Great Recession, prices for food, forest products, oil and gas and metals began to collapse. The gold price, for instance, has dropped some 40 per cent since its latest peak last year.

The “middle income trap.” Postwar Japan used cheap labour and efficient manufacture of Western knock-offs to rise from the ashes. But it soon shifted to quality, innovation and productivity gains to sustain and build its affluence, even as wage demands caused it to lose its cheap-labour advantage. By contrast, most emerging economies are caught in a trap: upward pressure on wages to meet the expectations of an increasingly prosperous population have weakened their cost-competitiveness, yet these countries cannot quickly build a knowledge-based economy by which countries move up the “value chain,” as Japan did. Between 2006 and 2011, the average annual wage increase in China’s 13 largest cities was a stunning 22 per cent. That accounts for an export-revenue drain to lower-cost Cambodia, Vietnam and Bangladesh.

Between 2005 and 2010, global investment in emerging-market stocks roughly quintupled. But as the developing world’s GDP growth rate has plummeted from a high of 9 per cent in 2009 to 3.7 per cent in this year’s first quarter, investor cash flows have largely dried up.

Dismal as this picture looks, recall that the early stages of the industrial revolutions in Britain and North America were also characterized by reliance on cheap labour, including child labour; by infrastructure over-building (Wilfrid Laurier was easily gulled by feckless railway promoters); and by chronic financial-markets “panics.”

Meanwhile, South Korea and Taiwan, having diversified their economies, remain economic dynamos. Despite pockets of civil-war violence raging in the country, the Philippines is booming. So is a Mexico confronting drug lords and bureaucratic sclerosis with resolve.

There will be another emerging markets boom, just as the latest one came on the heels of a previous cyclical low point, the Asian currency crisis of the late 1990s. “Emerging nations still represent 80 per cent of the world’s population and just 40 per cent of global GDP, so there is room for growing prosperity,” notes Ruchir Sharma. “Just not in every nation, all the time.”

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